How Medallion Loans Present an Existential Threat to Your Credit Union, Even If You Have Never Funded One.

by Michael Cochrum

When I was five years old, I was out playing in the yard with my brother and cousins after an afternoon thunderstorm in Western Kentucky.  We were playing near the creek that flowed behind our house that had swollen, from the spring rains, to twice its normal size.  What happened next is unclear based on individual testimony, but the consensus is that I ‘fell’ into the muddy creek and had to be ‘rescued’.  I swear that I felt a nudge before falling in and swallowing a mouth full of water, but no one else seems to remember that as clearly as I. 

After being rescued, I rushed into the house, probably crying, to dry off and get fresh clothes.  The only problem is, my mom was inside and once she got wind of what happened, she made us all come in for the rest of the afternoon.  Not only had I ‘almost died’ but now I was the ‘reason’ why everyone else had to spend the afternoon inside.  I was the one who spoiled it for everyone else.  I’m sure you have been the victim of similar circumstances where your fun was curtailed because of the careless act of someone else.

Credit Unions are faced with an existential threat today, due to the actions of other credit unions.  Do you think that is an overstatement?  Perhaps you haven’t read the OIG report on the NCUA’s oversight of Melrose CU,  LOMTO FCU and Bay Ridge FCU.  While inspectors rightly blame the credit union and its board for poor management practices, it goes further to conclude that the NCUA was not aggressive enough in its oversight.   The OIG also suggests that even credit unions that appear to be strong may require formal enforcement action to ensure safety and soundness.

In addition to the above observations, the inspectors made several recommendations.  The NCUA should institute a formal process to regularly analyze concentration risks that could pose a risk to the insurance fund.  Further, the NCUA agreed that the agency should set concentration risk thresholds for certain types of loans.  These new policies could be in place as soon as the end of 2010.  Additionally, it was recommended that the NCUA enhance its examination quality control procedures.  This will surely result in more detailed exams and intensive follow up on previous findings.  Finally, it was recommended that the scope of examinations be widened.  This means you will be asked to provide more detailed information on your credit union’s risk management procedures, including risk analysis.

So how does this pose an existential threat to some credit unions?  Because it requires a higher level of risk analytics that is not currently taking place in the credit union and that many credit unions do not have the resources to provide today.  One interpretation of the above observations and recommendations could suggest that even an otherwise healthy credit union could be liquidated or forced into merger, simply because management can’t prove that it is properly managing risk. Quite honestly, this is probably what should happen.  Two decades ago, when I came into this industry, we used to be proud that the insurance fund had never taken a loss.  In the last twenty years, credit unions’ risk exposure has changed so significantly that there are many hidden risks that are still difficult to find.  In 2010, when I suggested that credit unions fully consider the risks of medallion loans, I was criticized by a number of leading lenders who believed there was virtually no risk associated with these loans. But, we are all embarrassed when a previously healthy credit union goes in the tank, especially when that happens in an otherwise healthy economy.

Does anyone expect the NCUA to take this guidance lightly?  No, and in fact, I have already worked with credit unions that have been asked, by the NCUA, to test their concentration risk thresholds.  But, just like when my mom made all the kids come in the house after my ‘incident’, you can bet the NCUA is going to hold every credit union to a higher standard today, because of the results of this investigation, even when it doesn’t seem particularly reasonable to do so.

Transparency is the key to survival in the future.  In the same week we receive the news of the OIG report, we receive news of the failure of a $20 million credit union due to a $40 million embezzlement by its manager who was ‘cooking’ the books.  This can only happen in an environment that doesn’t take data and analytics seriously.  Questions should have been asked a long time ago, and perhaps they were.  I suspect that there was more than one former employee who would share of their personal attempt to bring anomalies to light.  But this can’t be done in an organization that doesn’t insist on transparency in reporting and analytics at the highest levels.  When organizations allow business units to ‘silo’ their reporting, the organization takes a huge risk.  How often have we heard of celebrated enterprises falling into the great abyss, simply because no one was watching?  I believe someone will be watching now. 

About the Author:

Michael Cochrum is CEO/CDO of CUBI.Pro, a company that specializing in working with financial institutions on data transformation projects.  Michael has worked in the financial services industry for almost 30 years and with, or in, credit unions for the last 20 years.  He holds a B.S. in Data Analytics and earned his MBA from Texas A&M – Corpus Christi.  You can email Mr. Cochrum with questions at michael.cochrum@cubi.pro or visit the www.cubi.pro website.